Question 1

Other things held constant,the more debt a firm uses,the lower its profit margin will be.

Accepted Answer

When a firm uses debt, it incurs interest expenses which reduce its net income and hence, profit margin. Therefore, higher levels of debt are generally associated with lower profit margins, all else being equal.

Question 2

The advantage of the basic earning power ratio (BEP)over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

Accepted Answer

The basic earning power ratio (BEP) considers only a company's operating income and total assets, ignoring the effects of debt and taxes. This makes it a useful measure of a company's operating efficiency that is not affected by financial leverage or tax policies. In contrast, the return on total assets takes into account both operating income and financing expenses, including interest and taxes, making it a less specific measure of operating efficiency.

Question 3

The market/book (M/B)ratio tells us how much investors are willing to pay for a dollar of accounting book value.In general,investors regard companies with higher M/B ratios as being less risky and/or more likely to enjoy higher growth in the future.

Accepted Answer

This statement is true. A higher M/B ratio suggests that investors are willing to pay more for each dollar of a company's accounting book value, indicating that they believe the company is less risky and/or has higher growth potential.

Question 4

Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.

Accepted Answer

Market value ratios, such as price-to-earnings ratio and market-to-book ratio, are commonly used by investors to evaluate the growth potential and profitability of a company. Therefore, these ratios reflect how investors perceive the company's past and future performance, which is valuable information for management to assess and improve the firm's strategies.

Question 5

In general,if investors regard a company as being relatively risky and/or having relatively poor growth prospects,then it will have relatively high P/E and M/B ratios.

Accepted Answer

If investors perceive a company as being risky and/or having poor growth prospects, then they may be less willing to pay a high price for the stock. This would result in lower P/E and M/B ratios, not higher ones.

Question 6

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used the same or similar accounting methods.

Accepted Answer

Significant variations in accounting methods can distort financial ratios and make meaningful comparisons between firms more difficult. Firms use different accounting methods for various reasons such as industry norms, legal and regulatory requirements, management preferences, and differences in size and complexity. These variations in accounting methods can affect the way financial statements are prepared and presented, making it challenging to compare financial ratios between firms accurately.

Question 7

Other things held constant,the more debt a firm uses,the lower its return on total assets will be.

Accepted Answer

This is because the more debt a firm uses, the higher its interest expenses will be, which lowers its net income and, in turn, its return on total assets.

Question 8

The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year,depending on the time of year when the financial statements are constructed.

Accepted Answer

This statement is true. Companies with seasonal sales may experience significant fluctuations in their financial position depending on the timing of their financial statements, which may not fully reflect the company's true financial health.

Question 9

The return on common equity (ROE)is generally regarded as being less significant,from a stockholder's viewpoint,than the return on total assets (ROA).

Accepted Answer

The return on common equity (ROE) is actually more significant from a stockholder's viewpoint as it measures the company's ability to generate profits with the investor's capital. The return on total assets (ROA) only indicates how efficient the company is in using all of its assets to generate profits.

Question 10

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

Accepted Answer

The fixed assets turnover ratio can be used to appraise firms' effectiveness in managing their fixed assets, regardless of the proportion of fixed assets to total assets. However, a higher fixed assets turnover ratio generally indicates that a firm is using its fixed assets more efficiently.

Question 11

Other things held constant,a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.

Accepted Answer

The answer of Other things held constant,a decline in sales...

Question 12

The price/earnings (P/E)ratio tells us how much investors are willing to pay for a dollar of current earnings.In general,investors regard companies with higher P/E ratios as being less risky and/or more likely to enjoy higher growth in the future.

Accepted Answer

This is generally true, as higher P/E ratios indicate that investors are willing to pay more for each dollar of earnings, suggesting they have confidence in the company's future prospects. However, there may be other factors at play, and a high P/E ratio does not always guarantee future growth or success.

Question 13

The inventory turnover and current ratio are related.The combination of a high current ratio and a low inventory turnover ratio,relative to industry norms,suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Accepted Answer

The statement correctly states that a high current ratio and low inventory turnover ratio together suggest an above-average inventory level and/or obsolete or damaged inventory.

Question 14

Klein Cosmetics has a profit margin of 5.0%,a total assets turnover ratio of 1.5 times,no debt and therefore an equity multiplier of 1.0,and an ROE of 7.5%.The CFO recommends that the firm borrow money,use the funds to buy back stock,and raise the equity multiplier to 2.0.The size of the firm (assets)would not change.She thinks that operations would not be affected,but interest on the new debt would lower the profit margin to 4.5%.This would probably be a good move,as it would increase the ROE from 7.5% to 13.5%.

Accepted Answer

By increasing the equity multiplier to 2.0 through borrowing and buying back stock, the ROE would increase from 7.5% to 13.5%. Even with the lower profit margin of 4.5%, the increased ROE indicates that this would be a good move.

Question 15

The return on invested capital measures the total return that a company has provided for its investors.

Accepted Answer

The return on invested capital (ROIC) is a financial metric that measures the return that a company has generated for its investors, taking into account the amount of capital that has been invested in the business. It is typically calculated by dividing the company's after-tax operating income by its total invested capital.

Question 16

Suppose you are analyzing two firms in the same industry.Firm A has a profit margin of 10% versus a margin of 8% for Firm B.Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus one of 20% for Firm B.Based only on these two facts,you cannot reach a conclusion as to which firm is better managed,because the difference in debt,not better management,could be the cause of Firm A's higher profit margin.

Accepted Answer

The answer of Suppose you are analyzing two firms in...

Question 17

Other things held constant,the more debt a firm uses,the lower its operating margin will be.

Accepted Answer

The answer of Other things held constant,the more debt a...

Question 18

Suppose all firms follow similar financing policies,face similar risks,have equal access to capital,and operate in competitive product and capital markets.However,firms face different operating conditions because,for example,the grocery store industry is different from the airline industry.Under these conditions,firms with high profit margins will tend to have high asset turnover ratios,and firms with low profit margins will tend to have low turnover ratios.

Accepted Answer

The answer of Suppose all firms follow similar financing policies,face...

Question 19

Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed,two firms with the same EBIT must have the same ROA.

Accepted Answer

Two firms with the same EBIT can have different ROA if they have different asset bases. ROA is calculated by dividing EBIT by total assets, so if one firm has a smaller asset base than the other while generating the same level of EBIT, it will have a higher ROA. Similarly, if one firm has a larger asset base than the other while generating the same level of EBIT, it will have a lower ROA.

Question 20

The return on invested capital (ROIC)differs from the return on assets (ROA).First,ROIC is based on total invested capital rather than total assets.Second,the numerator of the ROIC is after-tax operating income rather than net income.

Accepted Answer

The statements are correct. ROIC uses invested capital instead of total assets and after-tax operating income instead of net income.

Quiz 4: Analysis of Financial Statements